TCS Daily

The Solution, Not the Problem

The
blaming and finger pointing began almost as quickly as the lights went
out. First it was the U.S. and Canada blaming each other for causing
this particular blackout, but inevitably the blame conversation turned
to larger issues of policy, and how something like this could happen in
such a heavily regulated industry.

Some
of the finger pointing in the national press has been at deregulation
-- if it weren't for deregulation, we would be better able to control
and manage the grid. This misguided contention is incorrect in a number
of ways.

First,
the "deregulation" that has occurred in electricity has primarily been
in opening up wholesale markets for power generators and their
customers (i.e., utilities), enabling people in Manhattan to
continue consuming power (and clamoring now for more regulation)
without Con Edison having to build more power plants on the island
itself. The existence and growing vitality of wholesale electricity
markets has created substantial value in the past decade, through
encouraging generation where it is cheapest and sales of power to where
it is most needed.

But
this limited amount of market liberalization has left the industry in
an awkward place. Generation is largely governed by market processes,
but transmission and retail distribution remain heavily regulated. The
investment decisions of transmission owners and the retail rates that
they can charge to their end customers all hinge on rate cases that are
decided by state-level regulators. The rates that regulators allow take
into account changes in costs, required investments, and the payment to
the utility of a rate of return on the assets they own. For much of the
past decade this rate of return has been substantially lower than what
utilities could earn from doing other things with their money, so they
did not invest in building much new transmission capacity or in
upgrading existing lines. Nor did a regulatory environment that is a
relic from the 1930s, constructed to govern and control local,
vertically integrated utilities, either have the incentive or the
wherewithal to force the utilities to invest in transmission assets
that would carry power to customers in other states.

This
lack of investment in the infrastructure that carries the product
exchanged in growing, vibrant wholesale electricity markets has become
a problem -- not an overnight problem, as those who follow the industry
have been concerned about transmission capacity for at least five
years. The numbers offered this weekend suggest that electricity volume
has increased 30 percent while transmission carrying capacity has
increased only 15 percent. This fact illustrates the mismatch between
the dynamic markets for wholesale power and the rigid, maladaptive set
of state-level regulations and incentives that govern transmission
investment decisions.

Markets
adapt to changing conditions. The existing electricity regulations do
not, and because of that, the transmission infrastructure has not
adapted to the increased demand on it from the increasing vibrancy of
wholesale electricity markets.

So
how do we proceed to ensure that a blackout of this magnitude does not
happen again? There are four things that can relieve the strain on the
grid. The knee-jerk reaction of many people is "build more wires!" More
wires will increase the carrying capacity of the system, and in some
cases transmission owners can add lines to existing paths. But this
approach faces some serious obstacles -- such construction is expensive
and time-consuming. Most importantly, though, getting new lines and
towers sited is increasingly difficult, as people and communities
object to having such large structures near them or strung overhead.

A
second option is to use new technologies, such as high-temperature
superconductors and sophisticated computer switching, to upgrade the
capacity of the existing power lines. While also expensive, this option
gets around the NIMBY issues that accompany the siting of new lines.

A
third option is to build more generation nearer to customer demand --
having more generators near Manhattan would reduce the need to transmit
power from Niagra. Again, though, NIMBY concerns have been a strong
constraint on large-scale generation construction near population
centers. One way to increase generation, though, is distributed
generation, which involves installation of small-scale generators
on-site. DG is particularly economical for high-rise buildings (indeed,
as we saw last Thursday and Friday, many buildings have DG for backup
power already), and can reduce or eliminate a building's need to be
connected to the grid. DG does increase the complexity of managing a
grid, though, because the grid has to be configured to accommodate DG
if they are going to be hooked into it.

A
fourth option is usually not discussed, because of the tendency to
think of the grid as a supply issue. We can, and should, use
market-based retail pricing to communicate customer demand into the
grid. Under the decades-old regulatory rules controlling the retail
sale of power, customer rates are set as averages over the entire year.
Averaged rates do not take into account the fact that the cost of
supplying power to customers can vary hourly. Averaged rates also give
customers no incentive to conserve when the cost of providing them with
power is high, such as during the late afternoon on a warm summer day
like last Thursday. Grid operators saw power flow anomalies as early as
three hours before the blackout that spread in nine seconds, and in
those three hours, if we had market-based retail pricing, even the
shifting of a few large customers could have lowered the peak demand
and prevented the power surge.

Both
reality and laboratory experiments show that electricity customers do
respond to price changes, and that both suppliers and customers are
better off from doing so. This option does not currently exist for most
customers in most places -- large or small, we cannot choose how to buy
and consume power. Imagine if the telephone industry still operated
this way; if it did, we would not have the vibrant, competitive,
thriving cellular phone alternatives that we do now. One major lesson
of this blackout should be the need to revise our obsolete electricity
regulatory model, and the ability of market-based retail choice to
lessen the strain on the transmission grid.

Lynne Kiesling (lynne.kiesling@reason.org) is director of economic policy at Reason Foundation and senior lecturer of economics at Northwestern University